Two Interesting Questions and Answers Jude Wanniski June 26, 1998

Two Interesting Questions, and Answers

Memo To: SSU Students on Summer Break
From: Jude Wanniski
Re: Q&A

Question from Steven Piraino: A year or so ago, I asked you if you believed that an increased savings rate would result in increased output. I know you are of the opinion, from a policy standpoint, that a high savings rate should not be a goal. However, I continue to be unsure of where you stand, theoretically, on savings rates. That is, do you believe an increase in the amount saved out of a given national income\output would increase national income\output? As I ask you this question, two of your statements [from last year's summer school] come to mind: A) the first is your statement that people do not save "to purchase capital goods." B) The second is your statement that if car purchasers were to increase their savings rates, ROI's would fall for investment in the automobile industry. Lately, I have been rereading Keynes' General Theory, in which he seems to state that producers determine the scale of future output based on their expectation of future consumption. That is, the amount of investment is determined by the amount of expected demand, or consumption, not by the amount of savings. The amount of savings, in the Keynesian model (as best as I can tell), is determined by the amount of investment. Any savings in excess of the amount of investment necessarily reduces expected future consumption and therefore, investment, equilibrating savings and investment at a level consistent with future expectations of diminished consumption. Thus, finally, my question reads: Are you of the Keynesian opinion that high savings rates are a detriment to growth?

JW: First you must remember that the concept of "savings" in a national economy — a system — has a different meaning than when it is applied to an individual who is a piece of a system. That is, in a system, all production is consumed. None is saved. Steven cannot save unless someone in the system is willing to borrow. Steven produces 10 apples je   and wants to save one. Jude will borrow one and consume it, giving Steven an IOU. If Steven produces 15 apples and wants to save 6, and Jude only wants to borrow one, five will rot. It is extremely important you understand that in the neo-Keynesian mathematical world, which developed after his death in 1946, there is very little room for dynamic thought. Keynes understood the concept of "animal spirits." He presented a view of the way the world works that was vague in its definition of "savings" and "investment." In the math world, when you are stuck with the formula <Production = Savings+Consumption>, you are forced into rigidities that don't apply to the interaction of human beings in a marketplace.

So I must first say that the first question you pose makes no sense to me, i.e., Do you believe an increase in the amount saved out of a given national income\output would increase national income output? If the national income is 100 and 80 is consumed and 20 is saved, in a static sense, all 100 is consumed, in a real sense. So you have to tell me much more than you have before I could hazard a guess as to the answer I think you want. I not only argue that we should not make the "savings rate" an objective of national policy. I argue we should not even think about it, that it confuses the issue of how the nation increases its wealth — which I think only occurs at a greater rate when impediments to the development of production are removed and/or replaced with ideas/policies that enhance productive efforts.

I never meant to leave the narrow impression that we don't save "to purchase capital goods." A hammer is a capital good. An individual, of course, must save out of his consumption to buy a hammer. The objective of the system as a whole is consumption, which involves in one way or another a satisfaction of our physical or emotional needs. A hammer becomes a consumer good only when someone develops a fetish for hammers, feeling good only when he can line his shelves and closets with hammers. That's what I meant to say, that we produce to consume — current goods and services or future goods and services. It makes me feel good to see the stock market rise this week, even though I know that I may never be able to consume all the goods represented by the current purchasing power of my portfolio. Certainly Bill Gates cannot.

The hodgepodge you present from your understanding of what you read in General Theory should tell you that the answer to your bottom-line question is not possible. Are you of the Keynesian opinion that high savings rates are a detriment to growth? In the static nature of the question, in which Steven wants to save more apples but nobody wants to borrow them, we see a detriment to growth, sure. But the problem doesn't really interest me. Keynes was interested in it because he had around him a Great Depression he did not understand. Goods were piled up everywhere but nobody was buying them. Say's Law, that supply creates its own demand, seemed to have broken down. He scratched his head until he came up with the hypothesis that there was a shortage of effective demand. People wanted to eat those apples. They were starving for apples. But they had no money. Too many apples being saved over here, too few apples being consumed over there. So have the government step in and buy the apples from those who have them, or better yet, tax them away, and give them to the needy. It is all very silly stuff when you look at it as I do, but that's only because I figured out what caused the Great Depression, and that it was a supply-shock operating in accordance with Say's Law. To wit, the Smoot-Hawley Tariff Act put up a wall between U.S. goods destined for shipment abroad, and the goods abroad destined for shipment to the U.S. The goods piled up on both sides of the wall because they were not produced for the domestic market. So no, a high savings rate is not necessarily bad for the economic growth and it is not necessarily good. I just can't tell without more information, although our Ph.D. economists think they can.

Question from: Greg Begaud: I've just joined in on the lecture series, and I think my question might be way behind the current level of study, but I'll ask it anyway. I'm afraid I'm not 100% clear on the gold standard. I think you mean that we should fix the paper dollar to a dollar value of gold (i.e., $350/oz.), and that the Fed should issue (or withdraw) money from the economy when the market price for gold moves - thus keeping the market price for gold at $350/oz. It seems to make sense to me. Gold sort of "proxys" for all goods and services and the public can be sure that their money is linked to something concrete that it can be exchanged for.

The reason I'm confused is that I always thought the gold standard meant that the dollar was fixed to a set weight of gold, and the government issued as much money as there is ounces of gold, and that the fiat money could then always be redeemed for the equivalent set weight of gold. You see, I'm not sure if this is exactly the same thing as what I've explained above. I don't think so. I think in this definition, you issue exactly as much money as there is gold, and that's it. You can't issue any more fiat currency unless you get more gold. When I read about the gold standard in some of Murray Rothbard's stuff I think he was talking about abolishing the Fed. I'm sure you'd be against this because you seem to be a bit politically/government minded, while MR was a bit of a free market anarchist. Is there a difference between your gold standard and, say, Murray Rothbard's idea of a gold standard? I think he called the gold standard between Bretton Woods and Nixon a "phoney" [sic]gold standard. If there is a difference could you please explain it, and give the reason why you believe your idea is better.

JW: Like Keynes, the late Murray Rothbard had trouble figuring out the Crash of 1929 and the Great Depression. He came to believe it was the result of monetary errors caused by the Federal Reserve. He argued that it had created too much money in the 1920s, which he saw as an inflationary era, and that the Crash was simply the bursting of an unsustainable credit bubble. This led to the argument that we would have been better off without the Fed, which had been created to manage the gold standard with an "elastic currency" and provide the function of a lender of last resort. He would have had us return to a private banking system of the kind that underpinned the gold standard of the 18th and 19th centuries. The Bank of England in that era was a private bank, after all, and it maintained the sterling price of gold at a fixed level, with only a temporary departure during the Napoleonic wars. Actually, the private Bank of England approximated the mechanics of the Federal Reserve as a central bank. Its notes of issue were convertible into gold, but because the Bank had been so assiduous in keeping the supply of money exactly equal to the demand for money at the sterling/gold rate, it did not have to keep much gold on hand. In 1821, David Riccardo had posited that money is working at the peak of its efficiency when the central bank need hold NO gold.

The Federal Reserve wasn't exactly constructed on these principles, because of a requirement that the paper currency in circulation had to have gold backing in the government vaults, dollar for dollar, at the rate of $20.67 per ounce. The Fed is actually a quasi-governmental institution, which means among other things that the profits it earns for the conduct of business are returned to the taxpayers. It was not and is not unreasonable that the U.S. government and its shareholders should gain from the conduct of the Fed's operations, which unites member banks in a way that helps them adjust to the differences that are always occurring in the 12 districts. What Rothbard saw in the 1920s was not an inflationary era — because the standard prices indices actually fell over that robust period of growth. It was the Fed being able to supply more "money," as distinct from more "currency," by supplying the banking network with reserves, which are also non-interest-bearing debt of the U.S. government, but did not have to be backed with gold.

As far as I can tell, the system worked beautifully during the Twenties and the Great Depression. The Fed had almost no room for error, because it was bound by the central task of maintaining the dollar/gold exchange rate. The system worked well during WWII, as the government was able to maintain the dollar/gold link and thus finance the enormous cost of the war at 2% interest rates. The Bretton Woods system worked less well and finally broke down because the demand-side economists who advised the two political parties came to chafe under its mechanical operations. Both Keynesians and Monetarists wanted to manage the dollar for different objectives. The Keynesians wanted more money in the system to produce lower unemployment, partly by making export goods cheaper on the world market. The Monetarists believed they could defeat the business cycle by adjusting the aggregate money supply — currency and reserves — by their scientific, mathematical principles.

There are several gold standard ideas floating around among supply-siders. The reason I think mine is best is that it attempts to be close to perfect, in a Riccardian sense. The Fed would be required to manage the dollar/gold exchange rate by adding or subtracting liquidity to the banking system, buying bonds by giving the banks reserves dollar for dollar, or selling bonds and withdrawing reserves, dollar for dollar. If you believe as I do that it worked like a charm during the Twenties, you will agree that Treasury could eventually dispose of its gold stocks, and the Fed could use gold solely as an error signal. This simplicity can also be conveyed to the rest of the world, as all the governments of the world would see that they could keep their money as good as gold without any gold in their vaults.

What's holding my idea back? It is essentially the reluctance of the economics profession to admit that the Fed was NOT the cause of the '29 Crash and the ensuing Depression. If the Fed can make errors of that magnitude when managing the gold standard to a "T," those elitists who believe they are more scientific are able to persuade politicians to leave the dollar floating. How long will it be before the economics profession agrees that I am right and it has been wrong? If you consider that I learned my economics from Arthur Laffer and Robert Mundell, and they both continue to insist that the Fed screwed up in the Twenties and Thirties while I do not, you can make your own time estimate. Then again, we could always elect Jack Kemp our President, and he would do it by executive order. He promises!